New Revenue Recognition Rules for 2019 May Create Significant Challenges for Manufacturers
We have been talking about this for quite some time, and it is finally here. Effective for 2019 calendar year-end reporting, private company revenue recognition practices for contracts with customers (FASB ASC Topic 606) under accounting standards generally accepted in the United States (U.S. GAAP) have changed. Every company is likely to be affected by the significant changes. Several of the new requirements under the new standard could result in changes to revenue recognition for manufacturers.
The new revenue recognition standard replaced the more than 100 different industry and transaction-specific guidelines with a basic, five-step framework. Under the new rule, companies must carry out the following steps with each contract with customers:
- Identify the contract;
- Identify the performance obligations in the contract;
- Determine the transaction price;
- Allocate the transaction price to the performance obligations; and
- Recognize revenue when (or as) the entity has satisfied a performance obligation.
The most important considerations for manufacturing companies under the new standard will include the following:
- Identifying whether an arrangement with a customer constitutes a contract under the new standard;
- Determining when to recognize revenue on identified performance obligations in contracts in order to depict the transfer of control of goods or services to the customer: generally either at a specific point in time or over time;
- Allocation of sales price and separate accounting for optional service and other extended warranties;
- Accounting for variable consideration, such as volume pricing and discounts; and
- Identification of upfront contract costs, such as sales commissions and tooling, that must be capitalized as assets and amortized over the life of the contract.
Under the new revenue recognition standard, there are broad-sweeping modifications to financial statement presentation as well as several new and enhanced disclosures that come along with it. Among the changes to disclosures and reporting are new requirements to describe the company’s accounting policies for compliance with the many complex facets of FASB ASC Topic 606, including how the company identifies and segregates performance obligations, the company’s transaction price allocation methods, when and how revenue is being recognized and how the company accounts for variable consideration, contract modifications, upfront costs and warranties.
FASB ASC Topic 606 provides for two optional methods for transitioning from the old accounting method to the new: the full retrospective approach and the modified retrospective (simplified) approach. The full retrospective approach requires an entity to restate all prior periods presented in the financial statements as if the period had originally been accounted for using FASB ASC Topic 606. A cumulative adjustment will be made to necessary balance sheet accounts and the opening balance of retained earnings as January 1 of the earliest year being reported on, and all comparative period information would be restated. The modified retrospective (simplified) approach allows the reporting entity to only apply the new revenue recognition standard to contracts that are in process as of December 31, 2018 and onward. The cumulative adjustment would be reflected in the opening balance sheet at January 1, 2019 through a change to the opening balance of retained earnings. Comparative periods would not need to be restated under this method of adoption. Entities should carefully consider each method of adoption and the impact it could have on its financial position, while taking into consideration the concerns of bankers and other users of the ﬁnancial statements.
Implementation of the new standard could create some serious challenges for manufacturers. If nothing else, there are substantial changes to financial statement disclosures that must be made in order to comply with FASB ASC Topic 606. We strongly recommend meeting with your CPA to discuss how any changes to your company’s financial statements could impact external decisions that are being made.
Contributing author: Benjamin A. Sumner, CPA, is an audit partner with over nine years of experience providing auditing, accounting and consulting services to a wide variety of privately-held businesses.For more information on the new revenue recognition standard, contact us today.